Today we'll look at AudioCodes Ltd. (NASDAQ:AUDC) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for AudioCodes:
0.14 = US$23m ÷ (US$244m - US$87m) (Based on the trailing twelve months to December 2019.)
Therefore, AudioCodes has an ROCE of 14%.
Does AudioCodes Have A Good ROCE?
One way to assess ROCE is to compare similar companies. AudioCodes's ROCE appears to be substantially greater than the 6.3% average in the Communications industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where AudioCodes sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, AudioCodes currently has an ROCE of 14% compared to its ROCE 3 years ago, which was 5.5%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how AudioCodes's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect AudioCodes's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
AudioCodes has current liabilities of US$87m and total assets of US$244m. Therefore its current liabilities are equivalent to approximately 35% of its total assets. AudioCodes has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On AudioCodes's ROCE
AudioCodes's ROCE does look good, but the level of current liabilities also contribute to that. AudioCodes shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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